Euro extends gains to a three-month high on the rate gap prospects

Euro rose on Tuesday against a basket of major rivals, extending gains for the fourth straight session against the dollar and surpassing $1.09 to a three-month high on hopes of shrinking the US-eurozone interest rate gap this year. 

The European Central Bank prepares to cut European interest rates for the first time since 2024, in the first step of policy easing in Europe, however such a process is expected to be slower than expected.

Inflation in Europe accelerated once more in May, in turn renewing pressures on European policymakers and hurting the odds of multiple ECB rate cuts this year. 

On the other hand, the odds of multiple Fed rate cuts in September and November improved following a spate of weak US data.

The Price 

The EUR/USD rose 0.1% to $1.0916, the highest since March 21, with a session-low at $1.0899. 

Euro rose 0.55% on Monday against the dollar, the largest profit since May 15 as US yields dipped.

European Rates 

Recent European inflation data reduced the expected rate cuts by the ECB from 75 to 50 basis points this year.

US Rates 

Recent data showed US manufacturing shrank again in May, while construction spending fell unexpectedly, indicating a slowdown in US growth.

Following the data, the odds of a September interest rate cut in September rose to 60%, and to 72% in November according to the Fedwatch tool. 

Rate Gap

The US/eurozone interest rate gap currently stands at 100 basis points, the lowest since May 2022, and is expected to expand to 125 basis points this week in favor of the US. 

The ECB 

Later on Wednesday, the ECB will hold its periodic policy meeting, widely expected to cut interest rates by 25 basis points.

ECB President Christine Lagarde will provide fresh clues on the prospects of European rate cuts and policy easing later this yeare. 

Euro Outlook

UBS’s analysts expect the euro to soften this week on profit-taking after strong gains in the past few weeks. 

However, the ECB could surprise us with a bullish stance on future policies, with a potential delay of the timing of the next rate cut, in turn underpinning the euro and sending it above $1.09.